Municipal Aggregation: A Community Response to Emerging Competitive Opportunities

REMARKS OF BLOSSOM A. PERETZ
Director
New Jersey Division of Ratepayer Advocate

Energy Deregulation Meeting for
Manchester Township
February 3, 1998, 10:00 a.m.
Manchester Township Municipal Office Building

Municipal Aggregation: A Community Response to Emerging
Competitive Opportunities

Good morning, Mayor Cameron and municipal officials. My name is Blossom Peretz and I am the Director of the Division of Ratepayer Advocate. Thank you for the opportunity to speak today.

The Division of Ratepayer Advocate represents and protects the interests of utility customers in New Jersey, including residential, small business, and industrial customers. This is an unorthodox mix of constituents for a traditional utility consumer advocate, but it reflects the fact that no consumer group is isolated from the economic well-being of the entire community. This is especially true in the new competitive environment for energy services.

I am here today to discuss how you may be able to benefit your constituents with lower energy costs and improved service offerings which are becoming available through deregulation and competition in the gas and electric industries, specifically by engaging in municipal aggregation. Aggregation is possible because sales of the commodity of gas and electricity are being "unbundled" from the distribution functions being performed by local utilities, and becoming competitive. This is similar to the unbundling of long-distance service from local exchange service which has been occurring over the past decade.

First, what do I mean by municipal aggregation?

Aggregation means consolidating or pooling numerous individual purchases of gas and electricity into a single very large purchase, and thereby being able to purchase energy on favorable terms through the highly competitive wholesale markets. Aggregation is one facet of energy deregulation and basically permits someone other than the existing utility to perform the function of buying power at wholesale and redistributing it at retail: The POWER to buy POWER at competitive rates.

Municipal aggregation can occur in various ways. On the simplest level, the municipal aggregator can simply consolidate all of its own municipal gas and electric accounts such as the street lights and the municipal buildings into a single account, stated on a single bill, craft an RFP and shop the wholesale market for the best available "total energy" deal. In so doing, it can look not only to the cost of power, but to the range of related services being offered by the power provider. What are the competing power suppliers offering in terms of conservation related services? What about load management programs? Are they willing to offer creative pricing and financing models?

Taking the model a step further, units of local government can band together -- counties, cities, towns, school districts; sewer and water districts; municipal hospitals -- and procure their energy related needs on a cooperative basis.

Taking the model a third step, the municipality (or group of municipalities) or a county (or group of counties) can act as agent for all, or a number of, its constituents. Under this model, the municipality puts out a request for proposal on behalf of committed or anticipated participants in the pool. The ultimate energy supply contracts will, however, be between the individual energy users and the provider, with the municipality free from financial risk and day-to-day headaches. An analogy for this sort of pooling occurs, for example, when voluntary organizations such as the Knights of Columbus, or the New Jersey Bar Association offer insurance coverage to their members through a preferred provider.

Finally, a municipality can actually become a licensed power marketer, actually buying and selling electricity on the wholesale market, for its own account and the account of others. I would discourage all but the most pioneering and risk seeking municipalities from doing this.

It must be remembered that aggregation, at whatever level, will only involve the energy portion of energy purchases, and related customer services, and that control over poles, wires and mains and rates for transmission and distribution service will remain with the local gas or electric utility, furnishing service under tariffs approved by the BPU.

Let me address the following questions regarding municipal aggregation:

(1) Will it work?
(2) Is it necessary?
(3) What is the favored model?
(4) Is it worth the trouble? and, finally,
(5) How and when do we get moving?

WILL AGGREGATION WORK?

Municipal aggregation will work if two conditions are met. First, that there are energy providers out there willing and able to compete against the local utility or if the local utility is willing to offer competitive rates in the new marketplace. Secondly, that the gas and electric industries are restructured so as to give these would-be competitors a reasonable chance to go head-to-head with the local utility. I am confident that if we can meet the second condition, the first condition will take care of itself.

The Division of Ratepayer Advocate is committed to insuring that electric restructuring creates the conditions needed for genuine effective competition, not illusory competition. For competition to work, the utilities cannot use their continuing monopolies over the poles, wires, pipes and mains used to deliver gas and electricity to gain an unfair advantage in the sales of energy flowing through those poles, wires, pipes and mains. First, this means that they cannot give their own gas and power marketing affiliates preferential access to the distribution systems, or to important system or customer information. In the language of deregulation we want to see structural unbundling of generation from transmission and distribution. Secondly, it means that the utilities cannot try to shift costs they incur for the benefit of their competitive activities to customers of their monopoly services. Thirdly, it means that the new "unbundled" pricing structure, and particularly the "stranded cost" component of this structure, must be such as to allow efficiently managed competitors a fair opportunity to earn a profit. Needless to say, however, the new primary structure must provide a safety net for the low income ratepayers.

The Division of Ratepayer Advocate believes that to create the truly level playing field needed to insure fair competition, competitive utility functions should, to the maximum extent possible, be legally separated from continuing monopoly functions. It also wants to limit stranded cost recovery to the bare minimum needed to preserve the financial integrity of utilities. The promise of competition is lower rates for all customers.

If we are successful, and if we build this truly level playing field, I am confident that competitors will come. We've seen this in industry after industry, and have seen very encouraging signs in those areas of the energy industry which have been opened to market competition.

IS AGGREGATION NECESSARY?

My next question is whether municipal aggregation is necessary. In other words, if private competition is so wonderful and efficient and if competitors are out there, why should local government become involved at all? First, when dealing with the municipality's own electric costs, activism in terms of consolidating accounts and soliciting a single total energy solicitation is the only way to maximize the benefits of competition. As regards the need for municipalities to aggregate for small residential customers, my answer is that while there will be no shortage of competitors out there in the wholesale markets, or seeking the business of large retail users, the costs of going after small retail customers might prove to be prohibitive, particularly given the natural inertia, caution, and confusion of small customers. Municipal aggregation can, at once, significantly reduce the start-up marketing costs to the new entrants, and provide the necessary push and comfort level needed to spur small customers to break old habits.

WHAT IS THE FAVORED MODEL?

My third question involves the preferred form or forms for municipal aggregation, which itself involves a number of questions. First, what services should be aggregated? I am of the view that aggregation should, at the least, be permitted for both natural gas and electricity, consistent with the growing tendency around the country for suppliers to offer "one-stop energy shopping." With the trend in the "convergence" between energy and telecommunications systems and services, it might eventually make sense for municipalities also to package cable, telecommunications, and even Internet offerings together with energy offerings. The City of Glasgow, KY, did just this when, with great success, it installed a coaxial cable system to offer combined energy management and cable TV services to its existing municipal electric customers. Recently, Delmarva Power and Light Company, which may soon be merging with the Atlantic City Electric Company, announced formation of a new local and long-distance telephone company.

Next regarding the form of aggregation: on what basis should customers become part of the municipal purchase pool? There are four separate models for this.

(1) Binding Aggregation: Citizens of the municipality vote by referendum, after discussion and education, to aggregate the electric load of small commercial and residential consumers within its jurisdiction and select an electric provider (or providers) to serve that load. All residential and small consumers are automatically enrolled into the service of the selected provider for a fixed period.¹

(2) Restricted Opt Out: Consumers are automatically enrolled into a municipality's electric aggregation program, but individual consumers have the ability under certain conditions to opt out of the program and take service from another provider. The ability to switch providers can be restricted by the municipality to enable it to reduce risks and bargain effectively for those consumers who remain aggregated.

(3) Unrestricted Opt out: Consumers are automatically enrolled into a municipality's electric aggregation program, but individual consumers have the unrestricted ability to opt out of the program and take service from another provider. The ability to switch providers cannot be limited in any way by the municipality.

(4) Opt In: The pool is open only to those consumers who affirmatively, and on their own initiative, elect to participate. This model does not reduce the potentially prohibitive marketing costs of alerting consumers to the existence of the aggregation program, persuading them of its benefits, and actually signing them up. Nor does it reduce the potentially prohibitive logistical difficulties and inherent risks of procuring an energy supply for a load of indeterminate size. It simply transfers these costs, difficulties, and risks to the aggregating municipality.

As we move down the continuum of these models from top to bottom, there is an apparent trade-off between the collective benefit that comes from assembling the largest and firmest pooled load, and deference to individual choice and initiative.

From the perspective of the community, the mandatory participation model works best because it permits the municipality to broker the largest and firmest block of load. From the perspective of the competitively bidding suppliers, the mandatory aggregation model is the most attractive, because it will be relatively easy to forecast future usage, which will be driven mostly by demographics, i.e. customers moving into and out of the community, rather than customer preference. Suppliers themselves must obtain commitments from producers or marketers to insure their access to sufficient power to meet maximum forecasted pool demand, and must often pay for the right to this power even if actual demand is far below forecasted demand. Thus, pools with predictable load are very desirable to suppliers and those governed by the mandatory model will attract the most favorable bids. Pools under this model will also have lowest level of transaction and administration costs. The mandatory model, however, denies individual constituents variety and choice in product offerings and identity of supplier.

The restricted opt out model gives customers freedom to leave the pool, but, for ease of administration and predictability, only at specified times: e.g. during the initial pool subscription period, and then at prescribed intervals such as once every two or five years. A supplier furnishing power to a pool governed under this model versus the mandatory model is subject to some additional administrative expenses, and some risk of customer preference departure, albeit only periodically. This risk will have to come at an additional cost.

The restricted opt out municipal aggregation model will, however, insure that the cost-savings benefits of retail competition inure to small customers while giving each customer a reasonable time period to understand and learn about the new competitive marketplace and the available alternatives to participating in the municipal aggregation. The unrestricted opt out model gives customers the unrestricted ability to choose alternative suppliers, but this additional choice imposes additional administrative costs and additional risks on the supplier serving the pool.

New Jersey's incumbent utilities appear to support the opt in model of municipal aggregation and appear to oppose the binding or opt out models. They have supported proposed legislation that would make this the only permissible model of municipal aggregation. The Ratepayer Advocate is concerned that the opt in model will be ineffective, because it will dilute the municipality's ability to negotiate an effective contract on behalf of constituents.

The Ratepayer Advocate believes that the restricted opt out model strikes the best balance between the goals of community benefit and individual choice. Nevertheless, the Ratepayer Advocate supports municipal aggregation legislation which will give municipalities the option to aggregate under all four municipal aggregation models, binding, restricted opt out, unrestricted opt out, and opt in, as well as the option not to aggregate at all. It is the municipality, acting on behalf of its constituents, which must make the final decision.

IS, AS SOME UTILITIES HAVE ASSERTED, THE OPT OUT MODEL A FORM OF "SLAMMING?"

Absolutely not.

"Slamming" is the name given to a practice which has sometimes occurred in the long distance telecommunications market where long-distance providers (or telemarketers acting on their behalf) will change customer's long distance provider without the customer's consent. Slamming is --

* Unauthorized and Non-Consensual : Neither the customer, nor its duly authorized representative has consented to the change.

* Deceptive: It usually involves a fraudulent misrepresentation that the customer has consented to the change, when, in fact, the customer has not. Moreover, the customer is given no advance notice of the intended change or invitation to opt out.

* Anti-consumer: Slamming is done to achieve personal gain at the expense of unwitting victims.

By contrast, municipal aggregation under the opt out model is

* Authorized and Consensual: The decision to institute an aggregation program on the unrestricted opt out model will be made by duly authorized and elected representatives acting under state law. Their actions are consensual in the sense that all actions by elected officials are made with the "consent" of the electorate.

* Open and Honest: The municipal officials making these decisions will do so openly, with appropriate opportunity for public comment and input. The ultimate choice of provider (which could well include the incumbent utility, or its affiliate) will be subject to Board approval.

* Pro-consumer: The choice of provider and terms of services under municipal aggregation programs will be made, not by private entities or individuals trying to profiteer off consumers, but by the legal representatives of the consumers acting for the consumers' benefit.

The mischaracterization of municipal aggregation as "slamming" is not only factually baseless, but suggests a lack of self-insight and misunderstanding of the democratic process by some utilities. Binding or opt out municipal aggregation, in essence, reopens to public deliberation and democratic decision making the question of who should be the community's provider of electricity. Under the status quo preferred by utilities, the incumbent utilities are, and will remain, the default provider of these electric generation services.² These utilities, themselves, however, obtained this mantle of default provider, not by exercise of individual consumer choice, but through government (generally local) action seventy five or even one hundred years ago. If, as argued by utilities, any present action by government founded on the public interest to change the long-standing default provider is "slamming," then New Jersey consumers were "slammed" to the mat a century ago, and have been pinned to it ever since.

The inflammatory rhetoric of "slamming" is, of course, a "red herring," and merely diverts focus from the central issue. If today's municipal decision makers can, through a competitive process, obtain the services of an electricity provider on more favorable terms than those being offered by the monopoly provider for the past century, the public interest dictates these municipalities be permitted to do so. Arbitrarily tying the public to the consequences of non-legally binding century old choices needlessly perpetuates the "monopolies of the past." If incumbent utilities can offer a competitively attractive default service, nothing prevents them from participating in the competitive process of selecting a new provider by submitting appropriate bids. Individual consumers who, for reasons of loyalty, custom, or otherwise prefer to stay with the utility, rather than switching to the new provider are free to do so through exercise of a simple and convenient option.

WILL POLITICS OR PATRONAGE IMPROPERLY INFLUENCE THE CHOICE OF PROVIDERS UNDER MUNICIPAL AGGREGATION?

Some have expressed concern in this regard that appropriate safeguards should be implemented to preclude this possibility, particularly for municipalities which proceed under the opt out model. The process should be open and conducted in accordance prescribed procedures; the ultimate decision should be based on clearly defined criteria through a competitively bid RFP, and subject to Board approval and challenge; finally, participants in the bidding process should (as is already the case regarding government procurement in New Jersey) be precluded from making gifts, giving favors, or otherwise seeking to influence the process inappropriately.

Another important question is whether municipal aggregation should be subject to regulation and be subject to the Local Public Contracts Law? I suggest that perhaps the entire process, including oversight over the letting and award of bids, should be established as part of electric restructuring legislation. The Ratepayer Advocate with its expertise in energy matters would make its offices available to assist municipalities and will be working with the Legislature to craft legislation. In general, the goal should be for the successful municipal aggregation bidder to provide services, as much as possible, on a turn-key basis. Operational headaches and financial risks will be the provider's, not the municipality's. Once the municipality chooses the provider, the municipality's involvement basically ends and that provider will function under the same sort of supervision as other private aggregators. Customer complaints would be directed to the provider, with arbitration or mediation if necessary. Only when the contract expires or under extraordinary circumstances, such as provider bankruptcy, would the municipality again need to become directly involved. Most importantly, in this new world of competition, if the level of service by the chosen municipal aggregation provider deteriorates, the main and best option available to dissatisfied customers will be, quite simply, to change providers. This, of course, is the most important benefit of competition: choice.

IS AGGREGATION WORTH THE TROUBLE?

The fourth question is, how much trouble will this municipal aggregation cause, and will it be worth the trouble to the municipal governing body?

First, once the templates are created, municipal aggregation need not be difficult or risky, particularly since the more technical aspects of aggregation can and should be handled by qualified technical experts. Regarding whether it will be worth this amount of trouble, although we must be realistic about the expected cost savings, I definitely think so. High energy costs are a burden to your constituents and your local economies. Moreover, as I noted, the current relationship between your constituents and the local utilities results from franchise agreements entered into many decades ago permitting utilities to use your public streets and rights-of-way.

Putting together a solicitation for both the municipality's own energy service needs, together with those of participating constituents, will, if nothing else, get the attention of your local utility and its unregulated affiliates. Even if the end result is to have the local utility, as it were, bidding against itself to provide better service, the community still comes out ahead. In Monroe Township, 86 percent of the Township's 12,500 have chosen to participate in a pilot program to aggregate retail electric load. The experience of municipal aggregation in Peterborough, NH suggests that there will also be significant interest from major power marketers, like Enron and New Energy Ventures. Cost savings were about 15%, which is higher than what I would anticipate here.

Even if the aggregation merely represents the accounts of local government bodies, genuine cost savings will still be available. The City of Philadelphia was able to reduce its energy costs by over $5 million per year, primarily by parlaying competitive opportunities available to large customers in the area of fuel substitution and self-generation into large cost savings. In California, the Association of Bay Area Governments put out an RFP for 104 local governments in the San Francisco area to provide up to 30 megawatts of firm power for one year. The Rhode Island League of Cities and Towns will probably be forming a similar purchase pool on behalf of its members. Moreover, aggregation, and the competitive options that come with competition, might offer qualitative benefits in addition to mere commodity cost savings, such as in conservation, high quality lighting, load management, and even fuel switching.

HOW WILL WE GET THERE?

So, where do we go from here? First, we will need legislation authorizing municipal aggregation. Our office will work with you and with the legislators to achieve this goal as part of comprehensive energy reform legislation. The input from the municipalities regarding the contents of this legislation is critical.

Secondly, municipalities will need assistance in aggregating loads. Drafting solicitations, evaluating bids, and negotiating contracts requires expertise. You may want to hire expert consultants. Our office is also there to assist and make this specialized know-how readily available to municipalities by sharing our own expertise. We look forward to working with the you and the League of Municipalities on this project.

Finally, we need to further explore the municipal advantages for aggregating telecommunications needs and to explore convergence of energy and telecommunications networks.

CONCLUSION

Being a smart community in the age of electric deregulation and telecommunications information and technology advances requires the assumption of new leadership responsibilities. Smart communities will be developing plans right now for investment in the new energy and telco competitive environments. This is a call for action and I urge you to start blowing the whistle now.

Footnotes

1) It would probably be unfeasible to include large users to a binding aggregation program. _Back

2) The incumbent utilities will perhaps remain the "default," and, indeed, exclusive providers of electricity delivery related services for the transition period from a monopoly to competition. _Back

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